Policy stuck in the doldrums? Consumers think so

This post is a guest contribution by Rebecca Wilder, author of the of the News N Economics blog.

Consumer confidence: that extremely coincident, but often cited as leading consumer spending indicator of really just job growth during recovery, has struck again, down nearly four points to 50.4 in July.

During the recovery phase of the business cycle, confidence is highly correlated with job growth. The chart below illustrates the recession and recovery path of consumer confidence since 1973. The 2007-2009 recovery in confidence − I mark the technical end of the recession at June 2009 but the exact month is not important − is tracking earlier “jobless recoveries” in 1990-1991 and 2001.

The problem is, we can’t afford (economically, that is) a jobless recovery this time around!

It is incredible that economists and economic reporters still focus on consumer confidence. Consumers are actually spending at a relatively high rate. (The savings rate is well below historical levels.) The problem is that they lost $8 trillion in housing wealth. The housing wealth effect on consumption is something that economists have known about for more than 60 years. It’s too bad that they seem to have forgotten and so have the reporters who cover this issue.

The problem is not confidence. It is a lack of money. That is why consumers are not spending more and will not anytime soon regardless of how happy they are.

In my view, it’s (more precisely) the lack of money during the recovery of a balance sheet recession (Richard Koo of Nomura developed this idea). In order to lower household leverage (i.e. pay down debt burden) the easy way, a significant increase in nominal income is needed, wage growth. And a significant increase in wage growth only occurs when the demand for labor is rising … precipitously. Only then will workers have enough pricing power (in aggregate) to demand sufficient wage gains in order to deleverage the safe way (not through default).

Recently, economists have been testing the theory that structural unemployment is rising (Economist.com post here). In my view, focusing on structural unemployment is just a policy excuse. It gives policymakers a reason to mitigate the large(r) policy impetus that is needed. Bad idea.

When the deficit hawks manage to remove the fiscal stimulus while the private sector is still deleveraging, the economy collapses and re-enters the deflationary spiral. That weakness, in turn, prompts another fiscal stimulus, only to see it removed again by the deficit hawks once the economy stabilises. This unfortunate cycle can go on for years if the experience of post-1990 Japan is any guide. The net result is that the economy remains in the doldrums for years, and many unemployed workers will never find jobs in what appears to be structural unemployment even though there is nothing structural about their predicament. Japan took 15 years to come out of its balance-sheet recession because of this unfortunate cycle where the necessary medicine was applied only intermittently.

Although this may appear to be a normal jobless recovery, the type of recovery from which consumers have prospered in the past through debt accumulation, it’s not. Job growth is key to the deleveraging cycle; and with forecasts of the unemployment rate in the 8%-10% range through 2012, still 7% in 2013, the prospect of sufficient private-sector income generation looks very gloomy.